Capital Budgeting ProcessA capital budgetlists the projects and investments that a company plans to undertake during future years.To create this list, firms analyze alternate projects and decide which ones to accept through a process called capital budgeting.This process begin with forecasts of each project’s future consequences for the firms such as the effect on revenues, or costs.Our goal is to determine the effect of the decision to accept or reject a project on the firm cash flows and work out NPV to assess the

Forecasting Incremental EarningEarning are not actual cash flowsIncremental earnings of a project is the amount by which the firm’s earnings are expected to change as a result of the investment decision.Example 1:You are considering whether to upgrade your manufacturing plant and increase its capacity by purchasing a new piece of equipment.The equipment costs $1million, plus an additional $20,000 to transport it and install it.You will also spend $50,00 on engineering costs

Operating expenses vs. Capital expendituresUpfront investment: marketing survey, develop a prototype, and launch an ad campaign…We call they are operating expenses in the year that they are incurred.Investments in plant, property or equipment called capital expenditures, and they are not listed as expenses when calculating earnings. Instead the firm deducts a fraction of the cost each year as depreciation.

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Operating expenses vs. Capital expendituresIn the below example, firm spent total $1,020,000 for purchasing, transporting and installing the equipment. Assume this equipment has a depreciable life of 5 years and this firm choose to use straight-line depreciation method.

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